topic 2 Flashcards
define a market
a market is a process through which potential buyers and sellers of goods and services interact to exchange goods and services.
what are the two types of market? give an example for each.
visible: food market
invisible: online shopping
define demand
Demand is the willingness and ability of consumers to buy goods and services at various prices in a given time period, ceteris paribus.
describe a demand graph.
- price on y-axis
- quantity on x-axis
- straight line D (demand) sloping downwards
define the law of demand
price and quantity have a negative, or indirect relationship:
- when the price increases you tend to buy less of a good as it becomes more expensive
- when the price decreases you tend to buy more of a good as it becomes more affordable
what is the cause of and reason for movement along the demand curve?
when price changes, ceteris paribus, due to the law of demand.
when price decreases, there is a(n) ——— along the demand curve.
extension- quantity demanded increases
when price increases, there is a(n) ——— along the demand curve.
contraction- quantity demanded decreases
what affects the amount by which Qd will change due to a change in price?
the Price Elasticity of Demand (PED) will affect the gradient of the demand curve (greater elasticity= smaller gradient)
explain the relationship between an individual consumer’s demand and market demand.
- individual consumer’s demand is a component of market demand
- market demand is the summation of all individual demand of all consumers
explain the differences between an individual consumer’s demand and market demand.
- the market demand curve is flatter than the individual demand curve
- individual demand does not always follow the law of demand whereas market demand always does
what is the cause of a shift of the demand curve?
changes in non-price determinants (demand determinants)
state the 5 main non-price determinants of demand
- income
- tastes and preferences
- future price expectations
- price of related goods (in the cases of substitutes and complements)
- number of consumers
if demand increases, the demand curve will shift to the ——
right
if demand decreases, the demand curve will shift to the ——
left
explain income as a demand determinant
for normal goods- as income increases, demand increases (ability increases)
for inferior goods- as income increases, demand decreases (willingness decreases)
explain tastes and preferences as a demand determinant
- Possible causes= marketing/branding
- As tastes move towards product, demand increases.
Explain future price expectations as a demand determinant
- future prices expected to increase, you will buy more (e.g. houses or stocks) so demand increases
- future prices expected to decrease, you will not buy but will sell so demand decreases
explain the price of related goods as a demand determinant
- substitutes- two rival products (eg nike/adidas): when price of one goes up, quantity demanded for it goes down so demand for the other goes up
- complements- two products that go together and are needed for each other, (eg car and fuel): when price of one goes up, quantity demanded for it goes down so demand for the other also goes down
explain number of consumers as a demand determinant
more people means demand for most products increases, e.g. food or clothes.
state 5 EXTRA demand determinants
- expectation of future incomes
- taxes on income
- changes to age structure of population
- seasonality
- interest rates
define supply
supply is the willingness and ability of producers to produce goods and services at various prices in a given time period, ceteris paribus.
describe a supply graph
- price on y-axis
- quantity supplied on x axis
- supply curve is upward sloping
state the law of supply
price and Qs have a positive, or direct relationship:
- when the price increases suppliers want to produce more as they will have higher profit margins (assuming other costs are constant)
- when the price decreases suppliers want to produce less as they will have lower profit margins.
describe the relationship between an individual producer’s supply and market supply
- individual supply is a component of market supply, which is the summation of all the individual supplies
- individual supply curve is generally steeper
what is the cause of and reason for movement along a supply curve?
a change in price; law of supply
what affects how big of a change in supply there will be based on a change in price?
the price elasticity of supply (PES); higher PES= smaller gradient
when price increases, there is a(n) —— along the supply curve
extension; Qs increases
when price decreases, there is a(n) —— along the supply curve
contraction; Qs decreases
describe shifts of the supply curve
- supply increases, rightward shift
- supply decreases, leftward shift
state the main 6 non-price determinants of supply
- changes in costs of factors of production (FOPs)
- prices of related goods (in the cases of joint and competitive supply)
- indirect taxes and subsidies
- future price expectations
- changes in technology
- number of firms
explain changes in costs of factors of production (FOPs) as a non-price determinant of supply
- if cost of production increases, supply decreases
- if cost of production decreases, supply increases
e.g. wages, rent, cost of machines
explain prices of related goods as a non-price determinant of supply
- Competitive supply; the factors of production can be used to produce more than one product but are limited to one (land can make apples or potatoes)
- Joint supply; when one good is produced, another is also produced at the same time (eg sheep for wool and meat)
explain indirect taxes and subsidies as a non-price determinant of supply
> subsidies- money given by the government to firms to help increase production (increase supply)
indirect taxes (eg VAT)- tax imposed by the government that increases the supply costs of producers (decrease supply)
explain future price expectations as a non-price determinant of supply
if suppliers expect prices to go up in the future, they decrease their supply today and save inventory to sell for a higher price in the future.
explain changes in technology as a non-price determinant of supply
better machines cause efficiency/productivity to increase, increasing supply
explain number of firms as a non-price determinant of supply
if number of firms increases, supply increases, more production of the product
name the extra 2 non-price supply determinants
weather, supply shocks (sudden events)
what happens when quantity supplied is independent of price? why does this happen?
supply curve goes straight up vertically
- immediate time (make more food NOW)
- fixed quantity of the good supplied now (eg theatre/stadium seats)
- fixed quantity and no possibility of producing more (eg original artwork)
define shortage
Qd>Qs; excess demand; upward pressure in price
define surplus
Qs>Qd; excess supply; downward pressure in price
state the 3 functions of the price mechanism
resource allocation
- signalling function
- incentive function
rationing/allocating function
define the price mechanism
the means by which decisions of consumers and businesses interact to determine the allocation of resources.
when is there market failure?
When the price mechanism results in loss of social welfare
describe the signalling function
changes in price provides information to both producers and consumers about changes in market conditions.
describe the incentive function
rational consumers and producers have an incentive to adjust their consumption and production in response to the signal.
describe the rationing or allocation function
Consumers and producers act on the signal and incentive in order to reallocate scarce resources.
define the free market
an economic system in which prices are determined by unrestricted competition between privately owned businesses.
what is market equilibrium?
when quantity demanded = quantity supplied
what is equilibrium price?
the price at which quantity demanded= quantity supplied
define consumer surplus
consumer surplus is the extra utility gained by consumers from paying a lower price in comparison to what they were willing and able to pay
define producer surplus
producer surplus is the extra revenue gained by producers from selling at a higher price in comparison to what they were willing and able to sell
define social/community surplus
Consumer Surplus +Producer Surplus
define allocative efficiency
when resources are allocated in the most efficient way from society’s point of view:
- no over or under-allocation of resources
- social surplus is maximised
- marginal benefit = marginal cost
MC= ?
marginal cost (supply)
MB=?
marginal benefit (demand)
Define elasticity
elasticity shows how sensitive/responsive one variable is to another
Define PED, or Price Elasticity of Demand.
PED measures the responsiveness of Qd (quantity demanded) due to changes in price.
Describe the diagram for a highly responsive or elastic good.
The slope/gradient will be flatter
Describe the diagram for a less responsive or inelastic good.
The slope/gradient will be steeper
State the formula for PED
PED= percentage change in Qd/percentage change in price
PED will always have a ——– value due to the ——–.
PED will always have a negative value due to the law of demand.
What is the rule for categorising PED?
Use the absolute value of the PED, ignoring the minus sign.
State the 5 ranges of PED
- inelastic
- elastic
- perfectly inelastic
- perfectly elastic
- unitary elastic
Describe an inelastic PED
- when (the Qd of) something is not very responsive (to changes in price).
- 0<|PED|<1
- %∆P>%∆Qd
- gradient of demand curve steeper
Describe an elastic PED
- when (the Qd of) something is very responsive (to changes in price).
- |PED|>1
- %∆P<%∆Qd
- gradient of demand curve flatter
Describe a perfectly inelastic PED
- vertical demand curve
- PED=0
- Qd does not respond to changes in P
Give an example of where a perfectly inelastic PED may occur
An essential medicine with no substitutes.
Describe a perfectly elastic PED
- horizontal demand curve
- PED= ∞
- Qd is entirely dependent on P (buyers will only buy at one price and no other)
Give an example of where a perfectly elastic PED may occur
very theoretical, but luxury products like high end cars
Describe a unitary elastic PED
- hyperbola demand curve
- |PED|=1
- %ΔP=%ΔQd
effect of a PED determinant on a demand graph
affects the slope of the curve
state the 4 PED determinants
- number and closeness of substitutes
- Degree of necessity
- proportion of income spent on good
- time
(never deprive people of time)
Describe number and closeness of substitutes as a PED determinant
- many and close substitutes= elastic (consumer can switch to other substitutes easily)
- few/remote substitutes= inelastic (consumers do not have as many options)
Describe degree of necessity as a PED determinant and give examples
- necessity= inelastic (eg medicine, food, water)
- luxury= elastic (eg holidays abroad, high end cars)
Describe proportion of income spent on a good as a PED determinant
- small proportion (cheap)= inelastic as disposable income Yd is not affected significantly
- large proportion (expensive)= elastic as disposable income Yd is affected significantly
Describe time as a PED determinant
- short term= inelastic (less time to change buying habits)
- long term= elastic (more time to change buying habits)
give an example of time as a PED determinant
if the price of petrol rises, in the short term there are limited things that you can do/choices, but in the long term consumers can exchange their big, highly consuming cars (eg jeeps) for smaller, less consuming cars (eg electric)
give the formula for total revenue
TR= no. of goods sold x price of goods sold
Describe relationship between PED and total revenue
If demand is price inelastic, total revenue will move in the direction of the price change.
If demand is price elastic, total revenue will move in the opposite direction to the price change.
Give 3 uses of PED for firms/governments
- pricing policies
- to determine tax burden (consumer/producer burden)
- to price discriminate
Describe the use of PED for firms
For pricing policies; knowledge of PED helps determine if they need to increase or decrease their prices in order to maximise revenue
- elastic good (%∆P<%∆Qd): prices should decrease
- inelastic (%∆P>%∆Qd): prices should increase
Define YED, or income elasticity of demand
YED measures the responsiveness of the Qd of a good due to changes in income
Give the formula for YED, or income elasticity of demand
YED= %ΔQd/%ΔY
Give the range of values for the YED of an inferior good
YED<0; as income increases, demand for the good decreases
Give the range of values for the YED of a normal good
YED>0; as income increases, demand for the good also increases.
Define income inelastic goods
- 0<YED<1
- %ΔY>%ΔQd
- eg necessities
Define income elastic goods
- YED>1
- %ΔY<%ΔQd
- eg luxuries
Describe YED curves for normal goods, both elastic and inelastic
- Income (Y) on y axis, quantity on x axis
- upward sloping curve
- income inelastic= steep gradient
- income elastic= flatter gradient
describe and draw an Engel curve
- as Y increases, Qd increases- good acts as a NORMAL good, so YED>0
- people don’t want to buy more of the good despite being able to, they have the max amount they want- good becomes perfectly inelastic, so YED=0
- The good is ‘beneath’ consumers- becomes inferior, so YED<0
define PES, or price elasticity of supply
PES measures the responsiveness of Qs to changes in price
what range of values must PES always be?
PES is always positive
state the 5 ranges of PES
- inelastic
- elastic
- perfectly inelastic
- perfectly elastic
- unitary elastic
give the formula for PES
PED= percentage change in Qs/percentage change in price
describe an elastic PES
- supply can change quickly as good is easily produced
- PES>1
- %ΔP<%ΔQs
- flatter supply curve
describe an inelastic PES
- supply can’t change quickly as good is not easily produced
- 0<PES<1
- %ΔP>%ΔQs
- steeper supply curve
describe a perfectly inelastic PES
- vertical supply curve
- PES= 0
- Qs not affected by changes in price
state 3 possible causes of a perfectly inelastic PES
- immediate time (make more food NOW)
- fixed quantity of the good supplied now (eg theatre/stadium seats)
- fixed quantity and no possibility of producing more (eg original artwork)
describe a perfectly elastic PES
- horizontal supply curve
- PES= ∞
- Qs is entirely dependent on P (producers will only make at one price and no other)
give a possible cause of a perfectly elastic PES
infinite global supply of a product
describe a unitary elastic PES
- PES=1
-%ΔP=%ΔQs - straight supply line that goes through the origin
state 5 PES determinants
- time
- mobility of factors of production
- unused capacity
- ability to store
- rate at which costs increase
describe time as a PES determinant
- immediate time: all FOPs are fixed, so supply is perfectly inelastic
- short run: some FOPs are fixed, so supply is inelastic
- long run: all FOPs are variable, so supply is very elastic
describe mobility of FOPs as a PES determinant
- higher mobility → more elastic (easier to change to another production with less costs when price rises)
- lower mobility → less elastic (harder to change to another production with less costs when price rises)
describe unused capacity as a PES determinant
- full capacity: inelastic as time is needed to buy new machines
- excess capacity: elastic as you can just start using the unused machines
describe ability to store as a PES determinant
- low ability: inelastic- can’t release stocks in market if demand increases suddenly
- high ability: elastic- you can release stocks if necessary
describe rate at which costs increase as a PES
lower rate= more elastic as firms have a longer period of time to adjust and respond
higher rate= less elastic as firms have less time to adjust and respond
give 7 reasons for government intervention in markets
- earn govt revenue
- support firms
- support households on low incomes
- influence levels of production
- influence levels of consumption
- correct market failure
- promote equity
state 4 main forms of government intervention in markets
- price controls: price ceilings (max prices) and price floors (min prices)
- indirect taxes and subsidies
(- direct provision of services - command and control regulation/legislation)
define a specific tax
a tax imposed on an absolute value per unit of good sold (eg fuel tax, tobacco duty, alcohol duty, sugar tax, like £1 per unit)
define an ad valorem tax
a tax imposed on a fixed percentage of the price of the good (eg VAT)
describe how an ad valorem tax changes a supply/demand diagram
ad valorem tax will cause an increase in the cost of production so the supply curve will decrease and shift to the left
steeper gradient than original supply curve
describe how a specific tax changes a supply/demand diagram
specific tax will cause an increase in the cost of production so the supply curve will decrease and shift to the left
same gradient as original supply curve
distinguish between an indirect tax and a direct tax
direct - a tax paid directly to tax authorities (ie tax on income)
indirect- taxes on expenditure (consumer->producer->govt)
why does consumer and producer burden depend on the PED of a product?
if the product is elastic, producer burden will be higher- producers will keep tax burden themselves as they do not want to lose customers due to raised prices
evaluate the effect of taxes on stakeholders in the market
consumers:
- More expensive products and then enjoy less (Q2)
- CS decreases
- Consumer expenditures depend on PED. If PED is inelastic then expenditures increase and if PED is elastic then expenditures fall
- Lower income groups suffer more as VAT is a greater proportion of their income (regressive tax)
- If the tax is placed upon a harmful good then consumers might benefit if they consume less
producers
- TR drops
- producer surplus decreases
- international competitiveness may fall because they now seem more expensive, causing exports to decrease
governments:
- Their tax revenues increase
- If the tax revenues are used efficiently then the whole society will benefit
society:
- Under allocation of resources since quantity will decrease so unemployment in the specific sector might increase
- deadweight loss since resources as misallocated, unless the tax is used to lower production of harmful goods
why do govt prefer to tax goods with inelastic PED?
Their tax revenues are higher
Less damage to producers
Less increase in unemployment
The tax burden will be spread amongst many consumers instead of few producers
give 4 reasons why govt give subsidies?
- To make necessities more affordable for lower income households
- To provide more merit goods (benefit society), eg vaccines/education
- To make domestic producers more competitive and thus to be able to compete with foreign producers and increase exports
- To protect the environment by subsidising green technologies
define subsidies
payments made by the government to producers to increase production
state the effect of subsidies on a supply/demand diagram
decrease cost of production so supply curve increases and shifts to the right
when PED is inelastic, benefit to producers due to subsidies is ? than consumers. why?
smaller; consumers were going to buy it anyways but now they can spend less
evaluate the effect of subsidies on stakeholders in the market
consumers:
- Cheaper products and they can enjoy more
- consumer surplus increases
- consumer expenditures depend on PED
producers:
- TR increases
- producer surplus increases
- international competitiveness may increase (when prices are lower, exports may increase)
- greater risk of producers becoming inefficient
- foreign producers will seem less competitive (small scale farmers from LDCs won’t be able to compete with large scale subsidised farmers ->inequity)
define maximum prices
prices set by the government below the equilibrium price, which prevents producers from raising the price above it.
give 2 examples of countries with maximum prices
Example 1 - Venezuela (milk, toilet paper, medicine and rice)
Example 2 - Manhattan ( rent controls)
give 3 reasons why maximum prices exist
To protect low income consumers from high free market prices
To restrict monopolies from raising prices and exploiting consumers
To resist very high salaries (caps on pay and bonuses, CEOs and NBA)
evaluate the imposition of maximum prices
- There is a shortage as Qd>Qs
- There is underallocation of resources
Consumers:
- sometimes they are better off as they enjoy the product at a lower price
- some are worse off as they don’t get to enjoy the product due to the shortage
- it is important to protect low income families from high food prices as food is the largest proportion of their income and so if prices increase they may not be able to buy necessities
Governments: lower tax revenues due to less VAT
Producers: their total revenue falls
Price mechanism is distorted and the rationing method fails as a result.
The impact on the different stakeholders depends on how low the Pmax was set (and the PES and PED, more elastic means more impact)
give 2 negatives of price maximums
limited quantity may be rationed unfairly:
- connections/favouritism (discrimination e.g people with small children may not get a house)
- Black markets ( the more inelastic the PED the more likely it is to have black markets)
how does the govt resolve problems created by the shortage?
Increase supply by providing subsidies
Increase supply by providing products themselves
Direct provision from imports from abroad given out by the government
define rent controls
the maximum legal rents in order to make housing more affordable for low income group
how do maximum prices affect supply/demand graph?
line BELOW equilibrium
give a real life example of rent controls
Rent control has been in force in many of Germany’s largest cities, including Hamburg, Berlin, Stuttgart and Munich, for many years. This stipulates that “cold” rents (excluding utilities) cannot be more than 10 percent higher than the local comparative rent.
define a minimum price
prices set by the government above the equilibrium price, that prevents producers from reducing the prices below it.
give 2 reasons for setting minimum prices
- To protect small scale producers (mainly farmers) from low market prices. They need to earn revenues that will allow them to enjoy good living standards
- To decrease the consumption of demerit goods (e.g. cigarettes, alcohol)
describe the effect of a minimum price on a supply/demand diagram
new line above the minimum
(-) Surplus: Qd<Qs
evaluate the imposition of rent controls
landlords:
- earn less.
- the ones that give their houses through black markets earn more
- When landlords switch to Airbnb in order to avoid rent controls, the supply of rented accommodation decreases (there is a max amount of days you can rent it)
tenants:
- some find cheaper accommodation
- some might find a lower quality house as landlords don’t have the incentive to maintain them
- some tenants are worse off as they don’t find any accommodation due to the shortage (Qd>Qs)
evaluate the effect of a minimum price
Consumers:
- need to pay a higher price and they enjoy less
producers:
- If the government intervenes (for agricultural products) and buys the surplus, causing their TR increase
- If the government doesn’t buy the surplus then some are better off as they sell at higher prices and some aren’t as they don’t sell due to the surplus.
government:
- Cost of buying the surplus -> opportunity cost
- Cost of transporting and storing the product (some products can’t be stored as they are perishable)
- What to do with the product?
- Inefficiency might occur: firms might overproduce if they know that the government will buy their excess supply
Over allocation of resources
The impact on the different stakeholders depends on how high the Pmin was set (and the PED and PES)
what can the govt do in response to the surplus after minimum prices are set?
- buy the product so demand increases
- advertise the product so demand increases
- increase tariffs so demand for domestic product increases
- set a quota so producers limit their production to Qd
what is the common agricultural policy?
EU policy to protect farmers
- Setting minimum prices for many agricultural products
- Setting import tariffs to protect from cheap imports
- EU purchases of surplus food to maintain minimum prices
define a minimum wage
Minimum wages are wages above the equilibrium wage in order to protect employees from earning very low wages
give 1 positive of the minimum wage
Some workers are better-off as they earn higher wages
give 4 negatives of the minimum wage
- Some workers are worse off as they can’t find a job now (some were fired due to the wage increase, so their living standards drop)
- Producers are worse off as their costs of production increase -> lower profits (impacts depend: capital intensive vs human intensive and the extent to which they can pass on the higher cost of production to the consumer)
- Domestic producers may relocate to take advantage of lower wages -> loss of domestic jobs
- Government will be worse off as they need to retrain some unemployed people, pay unemployment benefits and potentially lose votes
- Black markets might be created if workers illegally accept to work for lower wages. More evident when a country has poor immigrants or high rates of unemployment -> Loss government revenues
give 3 general evaluation points for the effects of minimum wage
- this affects low income workers
- the size of unemployment depends on the PED and PES for labour
- the size of unemployment depends and on how high the minimum wage is set
define market failure
Market failure is a failure of the free market to allocate resources efficiently. Allocative efficiency isn’t achieved and there is over or under allocation of resources.
what is an externality and when does it occur ?
a type of market failure that occurs when the consumption or production of a good or service, harms or benefits a third party
define a negative consumption externality
when the consumption of a good or service harms a third party and the third party isn’t compensated
give and explain an example of a negative consumption externality
Cigarette and smoking -> higher NHS costs
- Taxpayers having to pay for health treatment
- Passive smoking from someone else
what are demerit goods?
goods that create negative consumption externalities and harm the consumers who consume them
MSC
Marginal social cost (MSC) is the total cost society incurs from producing the next unit of the good.
MSB
Marginal social benefit (MSB) is the benefit that society gains from the consumption of an additional unit of a good
MPB
Marginal private benefit is the benefit that an individual gains from the consumption of an additional unit of a good
when does allocative efficiency occur?
when there is a socially optimum output; MSB=MSC and social/community surplus is maximised
where does actual market equilibrium occur?
at MPB=MSC
define a positive consumption externality
when consumption of a good or service benefits a third party who does not pay for it
give and explain a positive consumption externality
‘consuming’ healthcare:
- their own health is better
- will not pass illnesses to others
define a merit good
goods that create positive consumption externalities and benefit those who consume them
draw a labelled diagram for a negative consumption externality
elsewhere
define welfare loss
the lost welfare as a result of too much or too little production and consumption of a good or resource
why do governments keep demerit goods?
- tax revenue
- industry creates jobs
give 6 ways that governments try to reduce negative consumption externalities (eg smoking)
Regulations (eg bans/age restrictions)
Indirect taxes
Nudges
Pmin
Negative advertising
Importing a certain amount
explain how regulations/laws help reduce negative consumption externalities
demand decreases, so MPB falls
evaluate restrictions/laws as a method to reduce NCE
cons:
- unemployment might increase in the specific sector
- loss of government revenues from taxes
- smokers in the SR will be worse-off as they will enjoy less of the good
- need to monitor that laws are followed or else they will be broken
pros:
- but in the LR they will be better-off if their health improves
- non-smokers will be better off as the externality will decrease
explain how indirect taxes help reduce NCEs
supply decreases; MSC shifts to the left and quantity of the good moves closer to socially efficient level of output
evaluate indirect taxes as a method to reduce NCEs
- tax is regressive so poorer groups are worse-off
- Qd will not fall significantly if PED is inelastic
- difficult to accurately measure externality and thus correct it (you might over or under shoot). So difficult to set the tax at the right level to internalise the external costs.
define a pigouvian tax
an indirect tax that is imposed on any market that creates negative externalities, in order to eliminate the externality
explain negative advertisement/education as a method to reduce NCEs
demand decreases; MPB falls
evaluate negative advertisement/education as a method to reduce NCEs
- unemployment might increase in the specific sector
- loss of government revenues from taxes
- smokers might find it hard to quit
- non-smokers will be better off as the externality will decrease
congestion charge as an eg of decreasing NCEs
the effectiveness depends on how close or weak substitutes drivers think cars and public transportation are. Public transportation is usually less comfortable and takes longer
(-) Domestic businesses might see a decrease in their customers if it is harder for them to access the city centre and there are no other substitutes. Consumers might switch to online shopping.
(-) higher income groups will not be significantly affected as it is a small percentage of their income
(+) part of the externality is internalised
alternating license plates as an eg of decreasing NCEs
- households may buy 2 cars with different licence plates to be able to enter the city centre
- domestic businesses might see a decrease in their customers if it is harder for them to access the city centre and there are no other substitutes.
- Consumers might switch to online shopping.
define a positive consumption externality
when the production of a good or service benefits a third party
draw a diagram for negative consumption externality
elsewhere
give 3 ways in which negative production externalities can be reduced
- legislation & regulation
- carbon taxes
- tradable pollution permits
explain legislation and regulation as a method of reducing NPEs
supply decreases; MPC decreases and shifts to the left
define MPC
marginal private cost; the change in the producer’s total cost brought about by the production of an additional unit of a good or service.
evaluate legislation and regulation as a method of reducing NPEs
pros:
- cost of production might increase if firms need to pay to have their waste burnt or if they need to buy filters -> maybe higher prices for consumers
- less pollution -> sustainable growth
cons:
- need to monitor that laws are followed or else they will be broken
- high administrative costs to regulate all industries
- fines should be high in order to deter firms from breaking the law
- higher unemployment in specific industries
- firms might relocate to countries with more relaxed laws
- Regulatory capture
explain carbon taxes as a method of reducing NPEs
cost of production increases -> supply decreases; MPC decreases and shifts to the left
evaluate carbon taxes as a method of reducing NPEs
- cost of production will increase -> maybe higher prices for consumers
- producers might switch to “green” technologies in order to avoid carbon taxes
- less pollution -> sustainable growth
- more government revenues
- domestic firms might shut down if consumers import from abroad from countries with weaker environmental regulations
- difficult to accurately measure externality so usually tax doesn’t equal the externality (over or under shoot). If tax equaled externality then it would be internalised.
- higher unemployment in specific industries
- externality is internalised
is internalising an externality a good or bad thing?
Internalising externalities helps to create a more efficient and equitable allocation of resources by ensuring that the costs and benefits of economic activities are reflected in the prices paid by the participants, rather than being imposed on third parties.
explain tradable permits/cap and trade scheme as a method of reducing NPEs
supply falls; MPC decreases and shifts left
evaluate tradable permits/cap and trade scheme as a method of reducing NPEs
- cost of production will increase -> maybe higher prices for consumers
- difficult to set acceptable pollution level & measure how much each firm is polluting
- less pollution -> sustainable growth
- need to monitor that laws are followed or else they will be broken
- higher unemployment in specific industries
- externality is internalised
- Firms may relocate to other countries with more relaxed laws
- administrative costs to the government
give an example of tradable permits
EU Emissions Trading System (ETS)
- The permits for greenhouse gas emissions are distributed between the EU member countries
- Then each EU country distributes the permits to the firms
- Firms can trade permits. If they exceed their allowance then they will be fined if they are caught
- In order to help reduce pollution, each year the number of permits decreases in order for firms to strive to lower their emissions
draw a diagram for the EU trading system
elsewhere
ETS Main Disadvantage
The price per permit is very low because initially the EU issued many permits
state 2 policies to address pollution
subsidise cleaner firms and international agreements
why are international agreements required?
pollution is a global problem
explain how subsidising green firms helps reduce pollution
cost of production decreases-> supply increases for “greener” firms
evaluate subsidising green firms as a way to reduce pollution
- cost to the government
- subsidies should be given to such an extent that it is cheaper for the firms to use cleaner energy (e.g. solar power) instead of buying fossil fuels (substitutes)
- fossil fuel producers will be worse off but renewable energy producers will be better off
- less pollution -> sustainable growth
- higher unemployment in specific industries
- renewable energy (e.g. wind farms) may create visual and noise pollution and decrease property prices
give an example of international agreements as a way to help reduce pollution
e.g. KYOTO protocol (goal: reduce greenhouse gases), Paris agreement and SDGs
give 4 problems of using fossil fuels as energy sources
Demand for fossil fuels has increased (depleted)
When fossil fuels are burned, GHG are emitted into the atmosphere (a CAR) -> climate change: floods, extreme weather
Furthermore, sometimes when they are extracted oil spills occur which damage the area, the local communities and lead to many animals dying.
Their extraction & use generate external costs that threaten the future generations’ access to them (Negative production externalities)
how is sustainability threatened by LDCs?
LDCs rely primarily on agricultural goods or commodities for income-> pressure on land resources for subsistence purposes and for more intensive cultivation to support their livelihood-> deforestation and soil erosion
how do more developed countries exacerbate LDCs’ threat to sustainability?
LDCs often have debts
They are pressured by the IMF or the World Bank to increase export revenue and facilitate foreign direct investment (FDI) to repay their debts
Result: pollution and depletion of natural resources -> unsustainable growth in LDCs
give 2 characteristics of common access resources
Non-excludable- everyone can use it
Rivalrous- when one person uses it, this diminishes the utility for someone else
what is the problem with CARs?
over-used -> depleted-> Threat to sustainability:
Tragedy of the commons- Individuals benefit from exploiting the resource but the cost of exploitation is shared amongst everyone
define sustainable development
Sustainable development is the development that meets present needs without compromising the ability of future generations to meet their own needs.
give 6 examples of CARs
Common fishing grounds
Sheep grazing a pasture
Black rhinos
Forests
Oceans
Atmosphere
give 4 reasons why CARs are exploited
lack of price
lack of ownership
high poverty & pursuit of economic growth (mainly LDCs)
lack of regulations
6 ways in which governments try reduce exploitation of common access resources
Legislation (e.g. fishing seasons)
Tradable Permits (e.g. 10 fish/day)
- The EU fish quotas might be set at a high level because depletion of fish stocks continues
- Fishing boats throw back smaller dead fish in order to catch bigger ones and meet their quota
Fence areas (conservation areas)
Assign property rights
Privatize communal areas
Education
evaluate assigning property rights as a way to try and reduce exploitation of common access resources
(+) The negative externalities created can now be accounted for (e.g. individuals with property rights over a lake can sue companies that pollute the river)
(-) Individuals may not sue companies as it is very expensive and may take many years
(-) It may be difficult to determine the polluter in some cases (e.g. if a river is very long and there are many firms set near that river- Thames)
give the main strengths and limitations of govt policies to correct externalities and approaches to managing common pool resources
- challenges involved in the measurement of externalities
- degree of effectiveness
- consequences for stakeholders
pros and cons of international cooperation
- global nature of sustainability issues
- challenges faced in international cooperation
- monitoring and enforcement
Define positive production externalities
When the production of a good or service benefits a third party and the third party doesn’t pay for it
give an example of a positive production externality
firms producing using green technology and less harm to the environment, thus sustainable growth
draw a diagram for a positive production externality
underproduction of merit good as MPC, S < MSC
give 3 ways that govt could increase positive production externalities
Laws & fines (ie making it mandatory to do something)
subsidies (increase supply)
taxes (increase supply)
pros and cons of laws & fines as a way to increase positive production externalities
(-) cost of production might increase-> maybe higher prices for consumers (poorer consumers will be severely affected if the price of necessities increases)
eg for greener production technologies:
(+) less pollution -> sustainable growth
(-) need to monitor that laws are followed or else they will be broken
(-) fines should be high in order to make the firms adhere to the laws
pros and cons of subsidies as a way to increase positive production externalities
(-) higher cost to the government ->maybe higher future taxes
(-) opportunity cost -> less spending on other areas
eg (+) less pollution -> sustainable growth (in this case)
(-) difficult to accurately measure externality so usually subsidy doesn’t equal the externality (over or under shoot).
(-) higher unemployment in industries that aren’t subsidised
eg (-) subsidies should be given to such an extent that it is cheaper for the firms to use cleaner energy (e.g. solar power) instead of buying fossil fuels (substitutes)
pros and cons of taxes as a way to increase positive production externalities
(-) less tax revenues to the government
eg (+) less pollution -> sustainable growth (in this case)
(-) difficult to accurately measure externality so usually subsidy doesn’t equal the externality (over or under shoot).
(-) higher unemployment in industries that don’t use that technology
Define a public good
goods that are non-excludable and non-rivalrous
Why would public goods not be provided at all in a free market?
Due to the free rider problem- This occurs when people can benefit from a good/service without paying anything towards it.
what does non-excludable mean?
it is costly or impossible for one user to exclude others from using a good
when one person uses it, this diminishes the utility for someone else
3 types of goods:
- pure public
- quasi public
- private
- Pure public goods: goods that are non-excludable and non-rivalrous
- Quasi public goods: goods that are either non-excludable or non-rivalrous (e.g. roads with tolls)
- Private goods: goods that are excludable and rivalrous (e.g. diet coke)
Policies to overcome the lack of public goods in the free market
direct govt provision or public-private partnerships
MPC
Marginal private cost (MPC) is the cost a firm incurs from producing the next unit of the good
give 3 ways in which positive consumption externalities can be boosted
- subsidies
- legislation/regulation
- positive advertising
